CFTC Deals Out Royal Pain

Canadian Bank Is Accused of Massive 'Wash' Scheme to Garner Tax Benefits

By

Jean Eaglesham,

Jamila Trindle and

Caroline Van Hasselt

Updated April 3, 2012 11:36 am ET

Royal Bank of Canada
was accused by U.S. regulators of hundreds of millions of dollars in illegal futures trades with itself in order to reap tax benefits.

Royal Bank of Canada was accused by the CFTC of making hundreds of millions of dollars in illegal futures trades with itself to reap tax benefit, Jamila Trindle reports on Markets Hub. Photo: Reuters/Mark Blinch.

In a federal-court lawsuit filed Monday in New York, the Commodity Futures Trading Commission alleged a "wash trading scheme of massive proportion" by Canada's largest bank. From 2007 to 2010, officials at RBC coordinated with two subsidiaries on the purchase and sale of futures contracts that gave the right to sell stock later at certain prices, the CFTC alleged.

The alleged scheme eliminated the possibility that RBC would suffer any losses on the investments, while locking in "lucrative" Canadian tax breaks on dividend payments, according to the lawsuit.

The CFTC said the size of the alleged misconduct means the suit is one of the biggest ever brought by the agency, which has shown more signs recently of flexing its enforcement muscles because of expanded oversight powers under the Dodd-Frank financial-overhaul law.

An RBC spokeswoman denounced the allegations as "absurd." The 25-page civil lawsuit is "meritless and we will rigorously defend ourselves against such baseless allegations," the bank said in a statement Monday.

Wash trades are prohibited because they evade the basic pricing mechanisms of financial markets. The technique can be used simply to generate a commission, improperly boost trading volume or influence prices.

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A CFTC official declined to comment on whether the agency is investigating other financial firms for trades linked to similar tax-avoidance strategies.

The trades at RBC allegedly were orchestrated by a small group of senior officials. Regulators said officials coordinated the trading strategy "on a day-to-day basis" and passed along the information to two RBC subsidiaries that bought and sold offsetting positions.

RBC was accused of routing the transactions through OneChicago, an electronic futures-trading exchange in Chicago that is partly owned by
CME Group Inc.
CME 0.20%
The Canadian bank also designed specific instruments related to the transactions that were traded on OneChicago, according to the lawsuit. Representatives of OneChicago and CME declined to comment.

Trades between different RBC subsidiaries were the only transactions of certain of those products from 2006 to 2010, according to the CFTC.

In its statement, RBC said the trades were "fully documented, transparent, and reviewed by both the CFTC and the exchanges, and for the next several years were monitored by them." The spokeswoman said it is "absurd to now claim these trades were either fictitious or wash sales."

The regulator also alleged that RBC tried to cover up the scheme when questions about it emerged. In its suit, the CFTC said the RBC "willfully concealed" information and made false and misleading statements in response to inquiries by
CME
CME 0.20%
begun in 2005. "We have been very open with the CME regarding the transactions and their allegation is absurd," the bank said.

CME runs the regulatory functions of OneChicago.

According to the lawsuit, RBC officials told CME that the trades "qualify as arms length transactions" because each subsidiary had "separate account controllers." The bank also said the idea came from "staff in our Bahamas office," when it actually was hatched at the "corporate level," the CFTC alleged. The bank had no specific comment on this allegation.

The lawsuit is the largest wash-sale case the CFTC has ever filed, as measured by the notional dollar amount of futures contracts.

U.S. regulators alleged a "wash trading scheme of massive proportion" by Royal Bank of Canada. Pictured, RBC's headquarters building in downtown Toronto.
Bloomberg News

David Meister,
the CFTC's director of enforcement, said the action "should make clear that the CFTC will not hesitate to bring charges against even the most sophisticated market participants who unlawfully exploit the futures markets for their own gain."

Mr. Meister is a former federal securities-fraud prosecutor who left private practice in November 2010 to join the CFTC. During his first year in charge of enforcement at the agency, it filed a record-high 99 cases, though many of them were Ponzi schemes and investor-fraud cases.

The suit against RBC comes as the CFTC grapples with pressure to step up oversight of the futures industry after the failure of MF Global Holdings Ltd. in October. The securities firm's collapse led to an estimated $1.6 billion shortfall in customer funds. CFTC officials are investigating the mess and haven't filed any enforcement actions. related to MF Global.

Under the Dodd-Frank law, the CFTC has jurisdiction over a broader swath of derivatives, as well as enhanced powers to pursue fraud and manipulation in those markets.

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